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FxWirePro: German political crisis unlikely to drive euro vols but Italy shakes – Uphold short hedges

We don’t see any significant changes in EUR forecast following yet another turgid month in which EUR crosses have continued to respect the pitiful three cent range that has endured for over three months now.

While the abrupt deterioration in the Italian political landscape rounded off what has been almost a perfect storm for the euro over the past 4-6 weeks. The correction in the single currency was initiated by a rise in U.S yields and sustained by the extended soft patch in European data which has required investors to belatedly reconsider core assumptions about the extent of European reflation and the pace of ECB tightening (our economists have delayed their forecast of ECB lift-off by three months to mid-2019).

For a currency in the eye of a political storm, Euro spot and vols are ending the week on a surprisingly benign note, but their nearly unchanged week-on-week levels belie the intensity of the shockwave in Italian bonds that at one point threatened to re-open the wounds of the EU debt crisis. The first signs of easing in Italian political uncertainty – M5S and Lega agreed to form a government with a candidate for finance minister less Euro-skeptic than the original candidate, Paolo Savona –have seen EURUSD vols, especially in shorter-expiries, swiftly retrace nearly 100% of their gains at the time of writing following the mid-week implosion in BTPs. Options are once again left looking too sanguine relative to the still palpable nervousness in bond yields just as they were before the BTP shock.

At present, the government crisis in Berlin is not an issue for the FX market. What gives us that idea? A factor of this nature should lead to euro-idiosyncratic weakness – but we are not seeing that.

The only question is: under which circumstances would the crisis become relevant for the EUR exchange rates? Political experts are telling me that things have never been as tight as this for Chancellor Angela Merkel. If Merkel were to step down that would very much be market relevant.

Even if she was repeatedly criticised, even hated, in some peripheral countries for her crisis management policies she was nonetheless a decisive architect of the policies designed to successfully fight the crisis. If the Chancellor were to step down concerns about a rise of euro skeptical forces in Germany might quickly become an issue for the market. However, it is understandable why the FX market is ignoring the crisis in Berlin.

Now the ECB may have addressed the risk of an ‘accidental’ collapse of the single currency brought on for instance by a government inadvertently losing market access.

Keeping this political turmoil aside, the ECB communication made it clear that this central bank is in no rush to hike rates in the foreseeable future. However, for many other central banks who de facto follow the ECB (Riksbank, SNB etc.) that means there is no light at the end of the low-interest rate tunnel either.

On hedging grounds, initiate shorts in futures contracts of mid-month tenors with a view to arresting potential dips. The writers of futures contract are expected to maintain margins in order to open and maintain a short futures position. Courtesy: Commerzbank

Currency Strength Index: FxWirePro's hourly EUR spot index is flashing at -113 levels (which is bearish), while hourly USD spot index was at 150 (highly bullish) while articulating at 07:06 GMT. For more details on the index, please refer below weblink:

http://www.fxwirepro.com/currencyindex

The above indices are also conducive to the derivatives strategy as advocated above.

FxWirePro launches Absolute Return Managed Program. For more details, visit: 

http://www.fxwirepro.com/invest

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